Bargain Shopping In The Mall REIT Sector

Bargain Shopping In The Mall REIT SectorThe Mall REIT sector continues to get crushed as department store chains are scrambling to downsize space and reduce rent liabilities.

Today JC Penney (JCP) announced it plans to shutter 130-140 stores in the coming months in an effort to improve profit margins. Sears Holdings (SHLD) which includes the Sears and Kmart brands, also announced last month its plans to close 150 stores, and Macy’s (M) is closing 68 stores and cutting 10,000 jobs.

One REIT, Seritage Growth Properties (SRG), is actually benefiting from the demise as the REIT, spun-off from Sears in 2013, has embarked on an aggressive plan to redevelop Sears-leased space into higher-productivity properties.

When Seritage went public, the company had 100% exposure to Sears, and that exposure has been reduced by around 30% (or 70% now). Warren Buffett actually purchased shares in Seritage last year, a seemingly speculative bet for the value investor, especially since the REIT is hoping to cash as many rent checks as possible to fund ongoing development costs.

Fitch estimates that Sears could lose up to $1.0 billion in 2017 before pension obligations and capex, even with recent store closures, as same store-sales continue to fall by a high-single digit percentage after an 8% fall last year.

Fitch expects total Sears cash burn of ~$1.8 billion in 2017, with a similar amount the following year. As Sears’ financial condition deteriorates further, the company will come under increased pressure to redevelop its space.

According to Floris van Dijkum, with Boenning & Scattergood, Inc.,

Sears is burning through cash, while (Fitch) rates the company’s debt at “CC” and downgrading Sears Roebuck Acceptance Corp’s (SRAC) unsecured notes to “C.” In the first week of January, Sears successfully agreed to the sale of its Craftsman brand to Stanley Black & Decker for $525 million in up-front cash, with a further $250 million in three years, including additional payments based on several hurdles.

Floris van Dijkum estimates that “there could be 825 malls left in 10 years. Over medium term, internet could largely subsume an estimated $27 billion of annual retail sales derived from ‘C’ mall segment. This amount is in-line with our estimate of over $25 billion of sales which comes from the 30 most valuable malls in the country.”  He went on to explain that “ The market is currently assigning a greater than 40% risk that Sears will file for bankruptcy in 2017 , leaving SRG shareholders at potentially significant risk.”

The Penney’s news yesterday is yet another indicator that department stores are struggling, and although Sears seems to be the closest to extinction , the fact that Texas-based Penney’s is closing down around 13% of its stores (based on square footage) casts an aura of doom across the entire retail sector.

Some investors, like Buffett, recognize that there is opportunity in the chaos, and Mizuho’s Haendel St. Juste believes that now is the time to be tactical in the Mall REIT sector,

The ‘A’ mall REITs continue to enjoy sound fundamentals… we’ve noted improved sentiment towards the Mall REITs in our recent investors, helped by the perceived improved economic implications of the presidential results, the stocks’ sell-off since August and the undeniably cheap prevailing valuations.

St. Juste adds that “the mall REITs are better positioned to work today given the earnings clarity ‘clean up’ trade that has transpired through earnings, which has helped re-balance investor expectations for the sector, as well as for specific companies.”

While Seritage, CBL Properties (CBL), and Washington Prime (WPG) represent the lower-productivity category – due to lower sales generated per square foot – St. Juste (and other REIT analysts) consider the higher-productivity mall REITs like Simon Properties (SPG), Taubman Centers (TCO), and General Growth (GGP), to be the crème de la crème – meaning the malls are ‘A’ rated.

Marc R. Halle, Managing Director, Chief Investment Officer of Global Real Estate Securities, and Senior Portfolio Manager at PGIM Real Estate, explains that “it’s been a long time coming. Penney and Sears have a lot of stores to close. The internet has disintermediated a lot of sectors. The anchor is the intermediary between a group of retailers and the consumer . We don’t need an intermediary now.”

He went on to say that “the power of the anchor (store) has diminished over time. Anchors used to dictating terms. We look for the highest productivity malls.”

The REITs with the most exposure to JC Penney include Simon (69 stores), CBL Properties (54 stores), Washington Prime (44 stores), and Taubman Centers (4 stores). However, based on revenue, JC Penny represents just .30% of ABR (average base rent) for Simon. Washington Prime has the largest Penney exposure, based on gross leasable area, of 8.6%.

Within the Mall REIT sector, I have BUY ratings on Simon, Taubman, and Tanger Factory Outlets (SLT). To learn more, visit the Forbes Real Estate Investor.

Disclosure: I own shares in SPG, SKT, and TCO.

Brad Thomas is editor of Forbes Real Estate Investor. He is also the coauthor (with Stephanie Krewson-Kelly) of The Intelligent REIT Investor: How To Build Wealth With Real Estate Investment Trusts (Wiley/Forbes) and author of  The Trump Factor: Unlocking the Secrets Behind the Trump Empire (Post Hill).